Global Market Comments
March 27, 2018
Fiat Lux
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(TLT), (TBT), (USO), (GLD), (GS), (SPY)
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A reader emailed me yesterday to tell me that while visiting his daughter at a college in North Carolina, he refilled his rental car with gas for $1.39 a gallon.
So I got the idea that something really big is going on here that no one is yet seeing. I processed the possibilities in my snowshoe up to the 10,000-foot level above Lake Tahoe last night.
By the way, the view of the snow covered High Sierras under the moonlight was incredible.
For decades, I have dismissed the hopes of my environmentalist friends that alternatives will soon replace oil (USO) as our principal source of energy.
I have long agreed with the views of my fracking buddies in the Texas Barnett Shale that it will be decades before wind, solar, and biodiesel make any appreciable dent in our energy makeup.
It took 150 years to build our energy infrastructure, and you don?t replace that overnight. The current weakness in oil prices is a simple repeat of a predictable cycle that has continued for a century and a half. In a couple years, Texas tea will be posting triple digits once again.
I always thought that oil had one more super spike left in it. After that, it will fade into history, reduced to limited applications, like making plastics and asphalt, probably sometime in the 2030?s.
The price for a barrel of oil should then vaporize to $5.
But given the price action for energy and all other commodities I?m starting to wonder if this time I?m wrong.
I have watched with utter amazement while Freeport McMoRan (FCX) plunged from $38 to $3. I was gob smacked to see Linn Energy (LINE), admittedly a leveraged play, crater from $32 to 30 cents.
And I was totally befuddled to see gas major Chesapeake Energy (CHK) implode from $65 to $1.
Has the world gone mad?
When the data don?t match your view, it?s time to change your view.
Maybe there won?t be another spike in oil prices. Could its disappearance from the modern industrialized economy have already begun?
That would certainly explain a lot of the recent eye-popping price action in the markets. In five short years oil has dropped 82%. It did this while global GDP grew by 20% and auto sales, and therefore gasoline demand, has been booming.
Of course, you could just call all of this a big giant reversion to the mean.
Over the past 150 years, the average, inflation adjusted price of oil has been $35 a barrel. The price for gasoline has been $2.25 a gallon, exactly where it was in 1932, and where it now is in much of the country.
I know all of these numbers because I once did a study to see if oil prices are rigged (conclusion: they are). How can the price of a commodity stay the same for 150 years?
Wait, the naysayers announce. Things don?t happen that fast.
But they do, my friends, they do, especially in energy.
Until 1849, my ancestors were the largest producers of whale oil on Nantucket Island. (Our family name,? Coffin, was mentioned in ?Moby Dick? seven times, and was a focus of the just released film, ?In the Heart of the Sea.?)
Then this stuff called petroleum came along, wrested from the ground with new technology by men like Drake and Rockefeller. The whale oil market crashed, dropping in price by 90%, and virtually disappeared in two years.
My relatives were wiped out and moved to San Francisco, which they already knew from their whaling days, and where gold had just been found.
A half-century later, this thing called an ?automobile? came along meant to replace the ubiquitous horse and buggy. People laughed. It was loud, noisy, smelly, inefficient, and expensive. Only the rich could afford them.
You had to go to a drug store to buy high priced fuel in one-gallon tins. And it scared the horses. England passed a national automobile speed limit of 5 miles per hour, as cars were considered dangerous.
Then huge oil discoveries were made in Texas and California (watch ?There Will Be Blood?), the Hughes drill bit came along, and gasoline prices fell sharply. Suddenly cars were everywhere. The horse population declined from 100 million to only 1 million today.
All of this is a long-winded, history packed way of saving ?This time it may be different?.
I have on my desktop a Trade Alert already written up to buy the (USO) May, 2016 $9 calls. Today, they traded at $1.00. I?m just waiting for another melt down in oil to take a low risk punt on the long side.
If we rocket back up to $100, as many are predicting, these calls will be worth a fortune. But you know what, oil may only peak out at $44 this time. The trade will still make money, but not as much as in past cycles.
So, you better think hard about loading up on too many oil stocks at these distressed levels. Look what has already happened to the coal industry (KOL), which has essentially gone bankrupt.
You could well be buying into the buggy whip industry circa 1900.
There?s Got to Be a Better Way to Make a Living
Those of a certain age can?t help but remember that things for the US went to hell in a hand basket after 1963.
That?s when President John F. Kennedy was assassinated, heralding decades of turmoil. Race riots exploded everywhere. The Vietnam War ramped up out of control, taking 60,000 lives, and destroying the nation?s finances. Nixon took the US off the gold standard.
When people complain about our challenges now, I laugh to my self and think this is nothing compared to that unfortunate decade.
Two oil shocks and hyper inflation followed. We reached a low point when Revolutionary Guards seized American hostages in Tehran in 1979.
We received a respite after 1982 with the rollback of a century?s worth of regulation during the Reagan years. But a borrowing binge sent the national debt soaring, from $1 trillion to $18 trillion. An 18-year bull market in stocks ensued. The United States share of global GDP continued to fade.
Basking in the decisive victories of WWII, the Greatest Generation saw their country account for 50% of global GDP, the largest in history, except, perhaps, for the Roman Empire. After that, our share of global business activity began a long steady decline. Today, we are hovering around 22%.
Hitch hiking around Europe in 1968 and 1969 with a backpack and a dog-eared copy of Europe on $5 a Day, I traded in a dollar for five French francs, four Deutschmarks, three Swiss francs, and 0.40 British pounds.
When I first landed in Japan in 1974, there were Y305 yen to the dollar. Even after a strong year, the greenback is still down by 75% against these currencies, except for sterling. How things have changed.
We now live in a world where the US suddenly has the strongest economy, currency and stock market in the world. Are these leading indicators of better things to come?
Is the Great American Rot finally ending? Is everything that has gone wrong with the United States over the past half century reversing?
The national finances are hinting as much. Over the last four years, the federal budget deficit has been shrinking at the fastest rate in history, from $1.4 trillion to only $483 million.
If the economy continues to grow at its present modest 2.5% rate, we should be in balance by 2018. Then the national debt, which will peak at around $18 trillion, will start to shrink for the first time in 20 years.
And since chronic deflation has crashed borrowing costs precipitously, the cost of maintaining this debt has dramatically declined.
A country with high economic growth, no inflation, generationally low energy costs, a strong currency, overwhelming technology superiority, a strong military and political stability is always a fantastic investment opportunity.
It certainly is compared to the highly deflationary, weak currency, technologically lagging major economies abroad.
You spend a lifetime looking for these as a researcher, and only come up with a handful. Perhaps this is what financial markets have been trying to tell us all along.
It certainly is what foreign investors have been telling us for years, who have been moving capital into the US as fast as they can (click here for ?The New Offshore Center: America?).
It gets even better. These ideal conditions are only the lead up to my roaring twenties scenario (click here for ?Get Ready for the Coming Golden Age?), when over saving, under consuming baby boomers enter a mass extinction, and a gale force demographic headwind veers to a tailwind.
That opens the way for the country to return to a consistent 4% GDP growth, with modest inflation and higher interest rates.
Which leads us all to the great screaming question of the moment: Why is the US stock market trading so poorly this year? If the long term prospects for companies are so great, why have shares suddenly started performing feebly?
Not only has it gone nowhere for three months, market volatility has doubled, making life for all of us dull, mean and brutish.
There are a few short-term answers to this conundrum.
There is no doubt that the Euro and the yen have fallen so sharply against the greenback that it is hurting the earnings of multinationals when translated back to dollars.
This has cut S&P 500 earnings forecasts for the year. And these days, everyone is a multinational, including the Diary of a Mad Hedge Fund Trader, where one third of our subscribers live abroad.
Another short-term factor is the complete collapse of the price of oil. Again, it happened so fast, and was so unexpected, that it too is having a sudden deleterious influence of broader S&P earnings.
Go no further than oil giant Chevron, which just announced a big drop in earnings and a massive cut in its capital spending budget for 2016.
The final nail in the Q4 coffin has been bank earnings, which all took big hits in trading revenues. Virtually all were taken short by the huge, one-way rally in bond prices in recent months and the collapse of interest rates.
This happens when panicky customers come in and lift the banks? inventories, and trading desks have to spend the rest of the day, week and month trying to get them back at a loss.
I have seen this happen too many times. This is why the industry always trades at such low multiples.
With no leadership from the biggest sectors of the market, financials and energy, and with the horsemen of technology and biotech vastly overbought, it doesn?t leave the nimble stock picker with too many choices.
The end result is a stock market that goes nowhere, but with a lot of volatility. Sound familiar?
Fortunately, there is a happy ending to this story. Eventually, all of the short-term factors will disappear. Oil prices and bond yields will go back up. The dollar will moderate. Corporate earnings growth will return to the 10% neighborhood. And stocks will reach new highs.
But it could take a while to digest all of this. This is a lot of red meat to take in all at one time. If the market grinds sideways in a 15% range all year, and then breaks out to the upside once again for a 5% annual gain, most investors would consider this a win.
Once again, index investors will beat the pants off of hedge fund managers, as they have for the past seven years.
In the meantime, I doubt the stock indexes will drop more than 6% % from here, with the (SPY) at $189, and we have already seen a 6% hair cut from last year?s peak.?
Knock a tenth off a 16.5 X forward earnings multiple with zero inflation, cheap energy, ultra low interest rates and hyper accelerating technology, and all of a sudden, stocks look pretty cheap again.
As the super sleuth, Sherlock Homes used to say, ?When you have eliminated the impossible, whatever remains, however improbable, must be the truth?.
It?s All Elementary
There is no better sight to a hungry trader than blood in the water.
?Buy them when they?re cryin? is an excellent investment strategy that always seems to work.
There are rivers of tears being shed over the banking industry right now.
Federal Reserve officials openly told investors that after the December ?% rate hike that they would continue to do so on a quarterly basis. Only weeks later, a collapse in the stock market shattered this scenario to smithereens.
I doubt we?ll see any more Fed action in 2016.
This caught investors in bank shares wrong footed in a major way.
But wait! It gets worse!
Among the largest holders of American bank shares are the Persian Gulf sovereign wealth funds, including those for Saudi Arabia, Kuwait, Oman, Qatar, and the United Arab Emirates, my old stomping grounds. Pieces of me are still there.
The collapse in oil prices (USO) has put their budgets in tatters and they now have to sell stock to fund wildly generous social service programs. The farther Texas tea drops, the more shares they have to sell, and at $26 a barrel they have to sell bucket loads.
Had enough? There?s more.
The junk bond market (JNK) and oil company shares are suggesting that up to half of all American oil companies will go bankrupt sometime this year, mostly small ones. It all depends on how long oil stays under $40.
Unfortunately, the oil industry has been the most prolific borrower from banks for the last decade. The covenants on many of these loans require borrowers to pump and sell oil to meet interest payments NO MATTER THE PRICE! It?s a perfect formula for maxing out production and selling into a hole.
So fear of widespread energy defaults has also been dragging down bank shares as well.
Some of the moves so far in this short year have been absolutely eye popping. Bank of America (BAC) has plunged 31% from its recent high, while Citibank (C) is down 32% and JP Morgan is off 19%. Basically, they all had a terrible year just in the month of January.
Bank shares have been beaten so mercilessly that they are approaching levels last seen at the nadir of the 2009 financial crisis.
Except that this time, there is no financial crisis, not even the hint of one. For the past seven years, banks have been relentlessly raising capital, reducing leverage, and growing BIGGER.
They proved last time that they were too big to fail. Now they are REALLY too big to fail. Default rates aren?t even a fraction of what we saw during the bad old days. Energy industry borrowing is only a tenth the size of bank home loan portfolios going into the crisis.
Blame the Dodd-Frank financial regulation bill, which requires banks to hold far more capital In US Treasury bonds (TLT) than in the past, which by the way, are doing spectacularly well.
Blame ultra cautious management.
Whatever the reason, Big US banks are now solid as the Rock of Gibraltar.
Which means I?m starting to get interested. Interest rates don?t go down forever, nor does the price of oil. And scares about loan defaults are being wildly exaggerated by the media, as always.
But there is more than one way to skin a cat.
All of these companies issue high yield preferred stock with exceptionally high dividends. For example, Bank of America issued 6.2% yielding paper as recently as October. It is paying something like 8% now.
Since these securities are stock, you get to participate in price appreciation when the panic subsides. A guaranteed 8% return, plus the prospect of substantial capital appreciation? Sounds like a pretty good deal to me.
Google bank preferred shares and you will find an entire world out there of specialist advisors, dedicated newsletters and even day trading and hedging recommendations.
One thing to keep in mind here is that you should only buy ?non callable? paper. This prevents issuers from stealing your paper when better times return to cut their interest payouts.
There is another way to play this beleaguered sector.
You can buy the iShares S&P US Preferred Stock Index Fund ETF (PFF), which owns a basket of preferred stocks almost entirely made up of bank shares. As of today it was yielding 5.62%. To visit the fund?s website, please click link: https://www.ishares.com/us/products/239826/ishares-us-preferred-stock-etf.
Time to BUY?
There are very few people I will drop everything to listen to.
One of the handful is Daniel Yergin, the bookish founder and CEO of Cambridge Energy Research Associates, the must-go-to source for all things energy.
Daniel received a Pulitzer Prize for The Prize: The Epic Quest for Oil, Money, and Power, a rare feat for a non-fiction book (I?ve never been able to get one).
Suffice it to say that every professional in the oil industry, and not a few hedge fund traders, have devoured this riveting book and based their investment decisions upon it.
Yergin thinks that the fracking and horizontal drilling revolutions have made the United States the new swing producer of oil. There is so much money in the investment pipeline that American oil production will continue to increase for the next six months, by some 500,000 barrels a day.
Much of this oil is coming from heavily leveraged, thinly capitalized producers whose bankers won?t let them cut back a drop on production so they can maintain interest payments on their debt.
This new supply will run head on into the seasonal drop in demand for energy, when spring ritually reduces heating bills, but the need for air-conditioning has not yet kicked in.
The net net could be a further drop in the price for Texas tea from the present $31 a barrel, possibly a dramatic one into the teens.
Yergin isn?t predicting any specific oil price as a potential floor, as it is an impossible task. While OPEC was a monolithic cartel, the US fracking industry is made up of thousands of mom and pop operators, and no one knows what anyone else is doing.
However, he is willing to bet that the price of oil will be higher in a year.
Currently, the 96 million barrel global market for oil is oversupplied with 2 million barrels a day.
If the International Monetary Fund is right, and the world adds 3.0% in economic growth this year, we will soak up 1 million b/d of that with new demand.
In the end, the oil price collapse is a self-solving problem. The new economic growth engendered by ultra low fuel prices eventually drives prices higher.
Where we reach the tipping point, and the oil market comes back into balance, is anyone?s guess. But when it does, prices will go substantially higher. The cure for low prices is low prices.
This is why I listed energy as the top performing asset class this year (click here for my ?2016 Annual Asset Class Review? by clicking here.
The bottom line is that there will be a great time to buy oil companies, but it is not yet.
What we are witnessing now is the worst energy crash since the 1980?s, when new supplies from the North Sea, Mexico and Alaska all hit at the same time.
I remember the last time oil plunged to $8 a barrel, because Morgan Stanley then set up a private partnership that bought commercial real estate in Houston for ten cents on the dollar. The eventual return on this fund was over 1,000%.
This time it is more complicated. Prices lived over $100 for so long that it sucked in an unprecedented amount of capital into new drilling, some $100 billion worth.
As a result, sources were brought online from parts of the world as diverse as Russia, the Arctic, Central Asia, Africa, the Canadian tar sands and remote and very expensive offshore platforms.
Yergin believes that Saudi Arabia can survive for three years with prices at current levels. After that, it will burn through its $150 billion of foreign exchange reserves, and could face a crisis.
Clearly, the Kingdom is betting that prices will recover with its market share based strategy before then. They are playing for the long haul.
The transition of power to the new King Salman was engineered by a committee of senior family members, and has been very orderly.
However, King Salman, a Sunni, will have his hands full. The current takeover of Yemen by a hostile Shiite minority, the Houthis, is a major concern. Yemen shares a 1,100 mile border with Saudi Arabia.
Daniel says that a year ago, there was a lot of geopolitical risk priced into oil, with multiple crises in the Ukraine, Syria, Libya and Iraq frightening consumers, so trading levitated over $100 for years. Delta Airlines, Inc. (DAL) even went to the length of buying its own refiner to keep fuel prices from rising further.
US oil producers have a unique advantage over competitors in that they can cut costs faster than any other competitors in the world. On the other hand, they are eventually going head to head against the Saudis, whose average cost of production is a mere $5/barrel.
A native of my own hometown of Los Angeles, Yergin started his professional career as a lecturer at Harvard University. He founded Cambridge Energy in 1982 with a $7.00 investment in a file cabinet at the Good Will. He later sold Cambridge Energy to the consulting group IHS Inc. for a small fortune.
To buy The Prize at discount Amazon pricing, please click here.
I did not buy the rally in stocks this week for two seconds.
Once the S&P 500 (SPY) bounced off of the $190 level the first time, it was only a question of how soon to sell again. When I said ?Sell every rally in stocks this year,? I wasn?t kidding.
As it turns out, I caught the absolutely top tick in the (SPY) at $195.
That?s where I quickly bought the (SPY) February $202-$207 vertical bear put debit spread. Within hours, the index cratered an awesome $70 handles, and I was already looking at 70% of the maximum potential profit.
The great luxury of the S&P 500 SPDR?s (SPY) February, 2016 $202-$207 in-the-money vertical bear put spread is that it allows you to cash in on continued extremely elevated levels of the Volatility Index (VIX).
This is why the potential return is so high for a front month options spread already 7 handles, and now 12 handles in-the-money.
In the meantime, I continued to run big shorts in the (SPY) with my February 187 and $190 puts.
This was on the heels of cutting by half my (XIV) position at cost, and taking profits on my (SPY) January $182-$187 vertical bull call debit spread during the rally.
Since yesterday, I have cut the net exposure of my sizeable trading book from 40% to 0%. This is how you do it.
My lack of faith in this market can be measured by the bucket load.
I believe that oil (USO) hasn?t bottomed yet.
All we are seeing here is a round of natural short covering you would expect as the price bounces off the big round number of $30, something which computer driven algorithms love to do.
There are many more visits to the $20 handle for oil to come. Brent is already there.
If you have some magical insight into the price of oil, better than the entire industry combined, and are convinced that Texas tea bottomed yesterday, then you shouldn?t touch the S&P 500 SPDR?s (SPY) February, 2016 $202-$207 in-the-money vertical bear put spread. In that unlikely scenario, stocks rocket from here.
Then there?s China (FXI), whose continued turmoil will bring further US stock losses. I assure you, not even the Chinese know what?s going on in China. They are more like the unfortunate deer that is frozen in the headlights.
If the stock markets of the Middle Kingdom were either up or down 10% tomorrow, I wouldn?t be surprised.
I?m quite happy with the performance of the Trade Alert service so far in 2016.
Here we are only 8 trading days into the New Year and many traders have already blown up, including quite a few trade mentoring newsletters. We should be hauling in some big numbers in January and February.
This is how you trade a crash. Watch and learn. The opportunities are legion.
I firmly believe that simple solutions to our energy problems are in the process of coming out of the blue, and are something no one is thinking about now.
Add up the contributions of many small improvements, and the cumulative change will alter our economic future beyond all recognition. Here are two of them.
General Electric (GE) is now mass-producing their ?Smart Energy LED Bulb,? which can screw into a conventional socket and produce the same amount of light as a 60-watt bulb, but consume only nine watts of power.
Some 22% of America?s electric power supply is used for lighting, and this bulb could cut our total consumption by 17.6%.
Other bulb manufacturers are getting into the game, like Philips, Osram, Toshiba, and Panasonic, which are already offering more efficient designs. The downside is that, while they last 25,000 hours, or ten times longer than a conventional incandescent bulb, they will initially cost $15-$25.
Economies of scale are expected to bring costs down dramatically in a few years. The Department of Energy has selected Seattle as the test bed for an all LED (light emitting diode) public lighting system.
Here is another game changer for our energy woes. If you double conventional car engine efficiency, US oil consumption drops by half. This is not so hard to do. The US government has already mandated that US car makers achieve an average fleet mileage of 54.5 miles per gallon by 2025.
They are hoping this will lower the cost of gasoline to $1 a gallon by then. They may get their wish this year instead.
One of the first things you learn in a freshman level physics class is how inefficient an internal combustion engine is, using hundreds of moving parts operating at 500 degrees to convert only 25% of the energy input into to motion.?
Tesla?s (TSLA) entire electric drive train has just 11 moving parts, operate at room temperature, and convert 80% of its energy into motion. When they go to the mass market in two years with the $35,000 Tesla 3, it will have a huge impact on our overall energy picture
Add this in with the surging supplies of American shale oil, and the utter collapse of the price of Texas tea (USO) over the past six months is suddenly starts to make incredible sense.
After the market closes every night, I usually don a 60 pound backpack and climb the 2,000 foot mountain in my back yard.
To pass the time, I listen to audio books on financial and historical topics, about 200 a year (I?ve really got President Grover Cleveland nailed!). That?s if the howling packs of coyotes don?t bother me too much.
I also engage in mental calisthenics, engaging in complex mathematical calculations. How many grains of sand would you have to pile up to reach from the earth to the moon? How many matchsticks to circle the earth?
For last night?s exercise, I decided to quantify the impact of last year?s oil price crash on the global economy.
The world is currently consuming about 92 million barrels a day of Texas tea, or 33.6 billion barrels a year. In May, 2014 at the $107.50 high, that much oil cost $3.6 trillion. At today?s $32 intraday low you could buy that quantity of oil for a bargain $1 trillion.
Buy a barrel of crude, and you get three for free!
This means that $2.6 trillion has suddenly been taken out of the pockets of oil producers, and put into the pockets of oil consumers, i.e. you and me. Over the medium term, this is fantastic news for oil consumers. But for the short term, things could get very scary.
$2.6 trillion is a lot of money. If you had that amount of hundred dollar bills, it would rise to 250 million inches, 21 million feet, or 3,976 miles, or 1.2% of the way to the moon (another mental exercise). Tip this pile on its side, and you?d have a distance nearly equal to a round trip from San Francisco to New York.
The global financial system cannot move this amount of money around on short notice without causing some pretty severe disruptions. Expect a lot of bodies to float to the surface in 2016.
For a start, there is suddenly a lot less demand for dollars with which to buy oil. This has triggered short covering rallies in the long beleaguered Japanese Yen (FXY) and the Euro (FXE), which are just now backing off of long downtrends.
The fundamentals for these currencies are still dire. But the short-term trend now appears to be an upward one. The yen is tickling a one-year high against the buck as we speak.
The US Federal Reserve certainly sees the oil crash as an enormously deflationary event. The use of energy is so widespread that it feeds into the cost of everything. That firmly takes the chance of any interest rate rise off the table for the rest of 2016. The Treasury bond market (TLT) has figured this out and launched on a monster rally, as have muni bonds (MUB).
Traders are also afraid that the disinflationary disease will spread, so they have been taking down the price of virtually all other hard commodities as well, like coal (KOL), iron ore (BHP), and copper (CU). For more depth on this, see my piece on ?The End of the Commodity Super Cycle? by clicking here.
The precipitous fall in energy investments everywhere will be felt principally in the 15 US states involved in energy production (Texas, Oklahoma, Louisiana, North Dakota. Etc.). So, the consumers in the other 35 states should be thrilled.
However, the plunge in energy stocks is getting so severe, that it is dragging down everything else with it. ALL shares are effectively oil shares right now. In fact, all asset classes are now moving tic for tic with the price of oil. That effectively makes all of you oil traders.
Throw on top of that the systemic risk presented by the ongoing collapse of the Russian economy. The Ruble has now fallen a staggering 70% in 18 months, and there is panic buying of everything going on in Moscow stores.
The means that the dollar denominated debt owed by local firms has just risen by 300%. Any foreign banks holding this debt are now probably regretting ever watching the film, Dr. Zhivago.
Russian interest rates there were just skyrocketed. The Russian stock market (RSX) is the world?s worst performing bourse. How do you spell ?depression? in the Cyrillic alphabet?
And guess what the new Russian currency is?
IPhone 6.0?s, of which Apple is now totally sold out in Alexander Putin?s domain!
Thankfully, this is more of a European, than an American problem. But nobody likes systemic risks, especially going into New Year trading. It?s a classic case of being careful what you wish for.
Of the $2.6 trillion today, about $650 billion is shifting between American pockets. That amounts to a hefty 3.3% of GDP. Tell me this won?t become a big political issue in the 2016 presidential election.
Money spent on oil is burned. However, money spent by newly enriched consumers has a multiplier effect. Spend a dollar at Walmart, and the company has to hire more workers, who then have more money to spend, and so on.
So a shifting of funds of this magnitude will probably add 1.5% to U.S. economic growth this year.
Ultimately, cheap energy as far as the eye can see is a key element of my ?Golden Age? scenario for the 2020?s (click here for ?Get Ready for the Coming Golden Age?).
But you may have to get there by riding a roller coaster first.
Oil at $32?
I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr.
By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.
I am not Houdini, so I go downstairs to use the larger public showers.
We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American accomplishment.
I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip.
The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them.
Thank goodness for small algorithms.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.
Who knew that 95% of America is off the grid? That explains a lot about our country today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone 6.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2015 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Even the stay-at-home index players had their heads handed to them.
With the Dow gaining 3.1% in 2015, and S&P 500 almost dead unchanged, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for eight boring consecutive months before spiking repeatedly many times to as high as 52%. Most hedge funds lagged the index by miles.
My Trade Alert Service, hauled in an astounding 38.8% profit, at the high was up 48.7%, and has become the talk of the hedge fund industry.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
The Four Key Variables for 2016
1) Will the Fed raise interest rates more or not?
2) Will China?s emerging economy see a hard or soft landing?
3) Will Japanese and European quantitative easing increase, or remain the same?
4) Will oil bottom and stay low, or bounce hard?
Here are your answers to the above: no, soft, more later, bounce hard later.
There you go! That?s all the research you have to do for the coming year. Everything else is a piece of cake.
The Ten Highlights of 2015
1) Stocks will finish higher in 2016, almost certainly more than the previous year, somewhere in the 5% range and 7% with dividends. Cheap energy, a recovering global economy, and 2-3% GDP growth, will be the drivers. However, this year we have a headwind of rising interest rates and falling multiples.
2) Expect stocks to take a 15% dive. That gives us a -15% to +5% trading range for the year. Volatility will remain permanently higher, with several large spikes up. That means you are going to have to pedal harder to earn your crust of bread in 2016.
3) The Treasury bond market will modestly grind down, anticipating the next 25 basis point rate rise from the Federal Reserve, and then the next one after that.
4) The yen will lose another 5% against the dollar.
5) The Euro will fall another 5%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.
6) Oil stays in a $30-$60 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.
7) Gold finally bottoms at $1,000 after one more final flush, then rallies $250. (My jeweler was right, again).
8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.
9) Residential real estate has made its big recovery, and will grind up slowly from here for years.
10) The 2016 presidential election will eat up immense amounts of media and research time, but will have absolutely no impact on financial markets. Give your money to charity instead.
The Thumbnail Portfolio
Equities - Long. A rising but high volatility year takes the S&P 500 up to 2,200. Technology, biotech, energy, solar, consumer discretionary, and financials lead. Energy should find its bottom, but later than sooner.
Bonds - Short. Down for the entire year, but not by much, with long periods of stagnation.
Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro, but won't gain nearly as much as in 2015.
Commodities - Long. A China recovery takes them up eventually.
Precious Metals - Buy as close to $1,000 as you can. We are overdue for a trading rally.
Agriculture - Long. El Nino in the north and droughts in Latin American should add up to higher prices.
Real estate - Long. Multifamily up, commercial up, single family homes up small.
1) The Economy - Fortress America
I think real US economic growth will come in at the 2.5%-3% range.
With a generational demographic drag continuing for five more years, don?t expect more than that. Big spenders, those in the 46-50 age group, don?t return in larger numbers until 2022.
But this negative will be offset by a plethora of positives, like hyper-accelerating technology, global expansion, and the lingering effects of the Fed?s massive five year quantitative easing.
US corporate profits will keep pushing to new all time highs. But this year we won?t be held back by the collapsing economies of Europe, China, and Japan, which subtracted about 0.5% from American economic growth, nor weak energy.
US Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last six years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.
Technology and dramatically lower energy costs are the principal sources of profit increases, which will continue their inexorable improvements. Think of more machines and software replacing people.
You know all of those hundreds of billions raised from technology IPO?s in 2015? Most of that is getting plowed right back into new start ups, increasing the rate of technology improvements even further, and the productivity gains that come with it.
We no longer have the free lunch of zero interest rates. But the cost of money will rise so slowly that it will barely impact profits. Deflation is here to stay. Watch the headline jobless rate fall below 5% to a full employment economy.
Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.
A Rocky Mountain Moose Family2) Equities (SPX), (QQQ), (AAPL), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX)
For the first time in seven years, earnings multiples are going to fall, but not by much. That is the only possible outcome in a world with rising interest rates, however modestly.
If multiples fall by 5%, from the current 18X to 17.1X, profits increase by 10%, and you throw in a 2% dividend, you should net out a 7% return by the end of the year.
S&P 500 earnings fell by 6% in 2015, but take out oil and they grew by 5.6%. In 2016, energy will be a lesser drag, or not at all. That makes my 10% target doable.
That is not much of a return with which to take on a lot of risk. But remember, in a near zero interest rate world, there is nothing else to buy.
This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years.
The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory. Yet, that is years off.
After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not? Borrowing money at close to zero and investing in 2% dividend paying stocks has become the world?s largest carry trade.
Rising interest rates will have one additional worrying impact on stock prices. They will pare back mergers and acquisitions and corporate buy backs in 2016.
Together these were the sources of all new net buying of stocks in 2015, some $5.5 trillion worth. Call it financial engineering, but the market loves it.
Although energy looks terrible now, it could well be the top-performing sector by the end of the year, to be followed by commodities.
Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year expansion of leverage in the industry, it is ripe for a cleanout.
Solar stocks will continue on a tear, now that the 30% federal investment tax subsidy has been extended by five more years. Look at Solar City (SCTY), First Solar (FSLR), and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.
After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates.
Share prices will deliver anything but a straight-line move. Expect a couple more 10% plus corrections in 2015, and for the Volatility Index (VIX) to revisit $30 multiple times. The higher prices rise, the more common these will become.
Frozen Headwaters of the Colorado River 3) Bonds ?(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP), (KMP), (LINE)
Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with for breakfast, lunch, and dinner.
There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.
I have to confess that I am leaning towards the ?one and done? school of thought with regards to the Fed?s interest rate policy. We may see a second 25 basis point rise in June, but only if the economy takes off like a rocket and international concerns disappear, an unlikely probability.
If you told me that US GDP growth was 2.5%, unemployment was at a ten year low at 5.0%, and energy prices had just plunged by 68%, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.25%.
We clearly are seeing a brave new world.
Global QE added to a US profit glut has created more money than the fixed income markets can absorb.
Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse.
Fixed income turned out to be a winner for me in 2015, as I sold short every bond price spike from the summer onward. It worked like a charm.
You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.
The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 62 basis points, and Japanese bonds paying a paltry 26 basis points, US Treasuries are looking like a steal.
To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.
For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.
Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest a decade down the road.
But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse.
The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.
While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite.
A 2% handle on the ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.
There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.
These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, at lest for the near term.
So what will 2016 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice.
I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.
We could ratchet back up to a 3% yield, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2015 performance, taking it from $46 back up to $60.
You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.
Reaching for yield suddenly went out of fashion for many investors, which is typical at market tops. As a result, junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (AMLP) are showing their first value in five years.
There is also emerging market sovereign debt to consider (PCY). If oil and commodities finally bottom, these high yielding bonds should take off on a tear.
This asset class was hammered last year, so we are now facing a rare entry point.
There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax-free muni values.
The collapse of the junk bond market suddenly made credit quality a big deal last year. What is better than lending to the government, unless you happen to live in Puerto Rico or Illinois.
So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way, and mark to markets could be shocking.
Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.
One question I always get asked at lunches, conferences, and lectures is what is going to happen to the budget deficit?
The short answer is that it disappears in 2018 with no change in current law, thanks to steady growth in tax revenues and no big new wars.
And Social Security? It will be fully funded by 2030, thanks to a huge demographic tailwind provided by the addition of 86 million Millennials to the tax rolls.
A bump up in US GDP growth from 2% to 4% during the 2020?s will also be a huge help, again, provided we don?t start any more wars.
It looks like I am going to be able to collect after all.
A Visit to the 19th Century4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
Without much movement in interest rates in 2016, you can expect the same for foreign currencies.
Last year, we saw never ending expectations of aggressive quantitative easing by foreign central banks, which never really showed. What we did get, was always disappointing.
The decade long bull market in the greenback continues, but not by much. You can forget about those dramatic double digit gains the dollar made against the Euro at the beginning of last year, which we absolutely nailed.
The fundamental play for the Japanese yen is still from the short side. But don?t expect movement until we see another new leg of quantitative easing from the Bank of Japan. It could be a long wait.
The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.
The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?130 to the dollar sometime in 2016, and ?150 further down the road.
I have many friends in Japan looking for an overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.
With the US having the world?s strongest major economy, its central bank is, therefore, most likely to continue raising rates the fastest.
That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book. Now that the Yuan is an IMF reserve currency, it has attained new respectability.
But don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.
5) Commodities (FCX), (VALE), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (PHO), (FIW), (CORN), (WEAT), (SOYB), (JJG)
There isn?t a strategist out there not giving thanks for not loading up on commodities in 2015, the preeminent investment disaster of the year. Those who did are now looking for jobs on Craig?s List.
It was another year of overwhelming supply meeting flagging demand, both in Europe and Asia. Blame China, the one big swing factor in the global commodity.
The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $3.5 trillion in reserves to finance it.
It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. This trend ran head on into a decade long expansion of capacity by the industry.
The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.
The food commodities were certainly the asset class to forget about in 2015, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.
Not even the arrival of one of the biggest El Nino events in history could bail them out.
However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.
Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.
The easy entry points here are with the corn (CORN), wheat (WEAT), and soybean (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).
The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).
Snow Angel on the Continental Divide6) Energy (DIG), (RIG), (USO), (DUG), (DIG), (UNG), (USO), (OXY), (XLE), (X)
You are now an oil trader, even if you didn?t realize it. Yikes!
The short-term direction of the price of Texas tea will be the principal driver for the prices of all asset classes, as it was for the 2015.
The smartest thing I did in 2015 was to ignore the professional traders, who called the bottom in oil monthly, based on key technical levels.
Instead, I hung on every word uttered by my old drilling buddies in the Barnett Shale, who only saw endless supply.
Guess whom I?ll be paying attention to this year?
I expect oil to bottom in 2016, and then launch a ferocious short covering rally. But when and where is anyone?s guess.
If energy legends John Hamm, John Arnold, and T. Boone Pickens have no idea where the absolute low will be, who am I to second-guess them?
When that happens, a trillion dollars will pour out of the sidelines into this troubled sector. Energy shares should be top-performers in 2016.
That makes energy Master Limited Partnerships, now yielding 10%-15%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.
The Alerian MLP ETF (AMLP) does this for you in an ETF format (click here for details). At its low this fund was down by 41% this year. The last printed annualized yield I saw was 10%. That kind of return will cover up a lot of sins.
Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.
There is another tank car train right behind it. No wonder Warren Buffet tap dances to work every day, as he owns the railroad.
Who knew that a new, younger Saudi king would ramp up production to once unimaginable levels and crush prices, turning the energy world upside down?
They aren?t targeting American frackers, who at 1 million barrels a day in a 92 million barrel a day demand world barely move the needle. Their goal is to destroy the economies of enemies Iran, Yemen, Russia, and of course ISIS, which need high prices to stay in business.
So far, so good.
Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries.
At current prices, the energy savings works out to an eye popping $550 per American driver per year!
This will end our structural unemployment faster than demographic realities would otherwise permit.
We have a major new factor this year in considering the price of energy. The nuclear deal with Iran promises to add 500,000 to 1 million barrels a day to an already glutted global market. Iraq is ramping up production as well.
We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building. Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.
Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.
As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again.
Add to your long term portfolio (DIG), Exxon Mobil (XOM), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY).
Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.
These could be your big trades of 2016, but expect to endure some pain first, nor to get much sleep at night.
7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.
In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year.
We also see countless abandoned 19th century gold mines and the broken down wooden trestles leading to them, relics of previous precious metals busts. So it is timely here to speak about precious metals.
As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
We have already broken $1,040 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.
But the long-term bull case is still there. Gold is not dead; it is just resting.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs.
Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more.
This is why emerging market central banks step in as large buyers every time we probe lower prices. China and India emerged as major buyers of gold in the final quarter of 2015.
They were joined by Russia, which was looking for non-dollar investments to dodge US economic and banking sanctions.
For me, that pegs the range for 2016 at $1,000-$1,250. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV), which I think could hit $50 once more, and eventually $100.
What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip.
With US auto production at 18 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.
Would You Believe This is a Blue State?8) Real Estate (ITB)
The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.
My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
There is no doubt that there is a long-term recovery in real estate underway. We are probably 5 years into a 17-year run at the next peak in 2028.
But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.
While the sales figures have recently been weak, it is a shortage of supply that is the cause. You can?t sell what you don?t have, at least in the real estate business.
From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace.
At least, it has stopped going down, which has been great news for the financial industry.
There are only three numbers you need to know in the housing market for the next 20 years: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 86 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That's what caused the financial crisis.
If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?.
Banks have gone back to the old standard of only lending money to people who don?t need it. But expect to put up your first-born child as collateral, and bring in your entire extended family in as cosigners if you want to get a bank loan.?
There is a happy ending to this story. Millennials, now aged 21-37 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market. The Great Millennial Migration to the suburbs has begun.
As a result, the price of single family homes should rocket tenfold during the 2020?s, as they did during the 1970?s and the 1990?s, when similar demographic influences were at play.
This will happen in the context of a coming labor shortfall and rising standards of living. Inflation returns.
Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.
Remember too, that by then, the US will not have built any new houses in large numbers in 10 years. We are still operating at only a quarter of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with.
You will boast to your grandchildren how little you paid for your house, as my grandparents once did to me ($18,000 for a four bedroom brownstone in Brooklyn in 1922).
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.
If you borrow at a 3% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house for free.
How hard is that to figure out?
Crossing the Bridge to Home Sweet Home9) Postscript
We have pulled into the station at Truckee in the midst of a howling blizzard.
My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle.
The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the opener for Downton Abbey's final season.
I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.
Good trading in 2016!
John Thomas
The Mad Hedge Fund Trader
The Omens Are Good for 2016!
I had a fascinating dinner last week at Morton?s, San Francisco?s best steak restaurant, with one of John Hamm?s original investors.
You remember John, the legendary Texas oilman who saw fracking coming a mile off and made billions?
Since some of what my friend had to say came true in a matter of days, I thought I?d pass on the essence of our conversation.
The oil storage facility at Cushing, Oklahoma is full, at 480 million barrels. The US Strategic Petroleum Reserve has been full for a long time, with 713 million barrels (36 days of US consumption).
Contangos are exploding. It might as well be the end of the world for the oil industry.
The oil Armageddon is here, and the final flush is upon us.
There is a 50% chance we will bottom at $32/barrel, and another 50% chance that we go all the way down to $20. If we go down to $20, the last three ticks of the move will be $22?.$20?.$22. Then a saw tooth bottom will unfold between $24 and $32 which will last for several months.
There will be many chances to buy this bottom. There isn?t going to be a ?V? shaped bottom in oil this time, like we saw in past energy crashes.
The margin clerks and risk control managers are in control now, so we may see the final low sooner than you think. But it could be some time before we break $40 again to the upside and hold it.
The industry was really drinking the Kool-Aid with both hands to get it this wrong. Ultra low interest rates drove in billions in capital from first time oil investors looking to beat zero interest rates. They also saw China continuing an endless economic boom forever, and the energy demand that went with it.
In the end, they got both the supply and demand sides of the equation completely wrong on a global scale, always a recipe for disaster.
Many of the fields drilled in places like North Dakota would never have been touched during normal times. Then Saudi Arabia came out of left field with a grab for global market share that has yet to play out.
The seeds of this recovery are already evident. Chinese auto sales are up 19% YOY. China is buying all the cheap oil it can to fill up its own strategic oil reserve. Miles driven in the US are already up 4.6% YOY, which is a huge gain.
All of this will contribute to a higher US GDP in 2016.
Once we put in a final bottom in oil, don?t expect $100 a barrel any time soon. The ma and pa investor in the oil patch will not be back in this generation.
Marginal sources, like high cost Canadian tar sands, deep offshore, and some in North Dakota aren?t coming back either. These supplies needed $100/barrel just to break even.
Personally, my friend does not see oil topping $80/barrel this decade. He see?s a $62-$80 trading range persisting for a long time.
As the US has become more energy independent, the geopolitical factors have mattered less and less. That is why oil moved only $1 on an ISIS victory, the Paris attacks, or some other disaster.
To call the bottom in oil, watch the shares of ExxonMobil (XOM), Conoco Phillips (COP), and Occidental Petroleum (OXY). When they revisit their August lows, down 5%-10% down from here, that will be a great time to jump back into the oil space.
None of these companies are going under, and the dividend payouts are now enormous, (XOM) at (3.7%), (COP) at (5.8%), and (OXY) at (4.2%).
Distressed debt is where the smart money is focusing now, where double-digit returns have become common. If the issuer goes bankrupt the equity owners get wiped out while the bondholders get the company for pennies on the dollar.
Energy companies and master limited partnerships (MLP?s) have far and away been the biggest borrowers in the high yield market in recent years.
There is a junk maturity cliff looming, with $145 billion in bonds due for refinancing from 2017-2021. Expect the default ratio to rocket from this year?s 2.8% to 25%. A 12% default rate is a normal peak in a recession.
Individual company research now has a bigger payoff than in any time in history, even the 2008-09 crash.
Small leveraged companies with exposure to the price of oil are toast.
The play is for the toll takers, master limited partnerships that profit from the volume of oil pumped, and not the price of oil. Over time, volumes will increase, and so will the profits at these MLP?s.
In the meantime, everything is getting thrown out with the bathwater, regardless of fundamentals. People just don?t want to be near the space, especially going into yearend book closing.
Nobody wants to be seen as the idiot who owned oil in 2015.
Linn Energy (LINE) is a perfect example of this. It suspended its dividend so it could buy more assets on the cheap. It has plenty of cash, and will be backstopped by Blackrock with additional credit lines, if necessary.
While this raises volatility for the short term, it increases returns over the long term. It?s definitely your ?E? ticket ride.
I pointed out that President Obama did the oil industry the biggest favor in history by dragging his feet on the Keystone Pipeline, and then ultimately killing it. It prevented US consumers from loading the boat with $100/barrel tar sands crude at the top of the market.
My friend conceded that it is unlikely the pipeline would ever be built. The market has moved away.
I have accumulated a variety of odd tastes in my half-century of traveling around the world.
So when I heard we were eating at Morton?s, I brought my own jar of Coleman?s hot English mustard. It makes a medium rare cooked filet mignon taste perfect, but my action always puzzles the waiters. They never have it.
John Hamm gained public notoriety last year when he wrote a $974 million divorce settlement check to is ex wife and she refused to cash the check. I asked if the check ever got cashed?
?She cashed the check,? he said.
Needless to say, my friend picked up the check for the dinner as well. I let him drive my Tesla Model S-1 back to his hotel.
